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By Philippe Legrain ADD COMMENTS

This is not a very happy new year. Rail fares, energy prices and fuel duty are all being jacked up. And today VAT goes up from 17.5% to 20%.

Optimists claim that the economy is strong enough to shrug off the VAT rise. People barely noticed when VAT was cut from 17.5% to 15%, so why should a rise to 20% make much difference? In any case, the rise is necessary, George Osborne asserts, to help fill the gaping hole in the public finances.

It’s true that few people will balk at paying two or three pence more for a packet of chocolate digestives. But, over a year, it all adds up. During the election campaign the Liberal Democrats claimed that the “Tory VAT bombshell” would cost the average family £389 a year, a figure that Labour is now throwing back at the coalition government.

Worse, VAT hammers the poor hardest, because they spend almost all their meagre incomes, whereas the rich save a big chunk of theirs. The Institute for Fiscal Studies reckons that the VAT rise will lop 1% off the after-tax incomes of the richest 10% – and 2.25% off those of the neediest 10%. That is hardly progressive.

The VAT rise will not just hurt people’s pockets: it will adversely affect jobs and growth too. Lower consumer spending means fewer jobs for people making things and selling them. In April, national insurance will go up by 1%, equivalent to an extra penny on income tax – all this at a time when public-sector pay is frozen, private-sector wages are stagnant, benefits are being slashed and many people are struggling with huge debts, often secured against their depreciating homes. Add big public-spending cuts and the fiscal squeeze will take roughly 2% out of the economy this year.

Unless private investment takes off, the economy will stagnate, unemployment will rise and the deficit will fail to shrink much. The government would be cutting to stand still – lots of pain for hardly any gain.

Of course, the government’s gamble may pay off. As the public sector and consumers retrench, business investment and exports may boom. The government points to countries – such as Canada in the 1990s – that tightened their belts and continued to grow. But circumstances in Britain now are different. Whereas Canada and others offset their fiscal squeeze with monetary loosening, the UK cannot cut interest rates below 0%. Worse, banks deny credit to small businesses that want to invest. And whereas previous belt-tighteners benefited from booming exports, Britain’s main export markets – Europe and the US – are weak.

In the longer term, we need to tap into the boom in emerging economies such as China, India and Brazil, but that will take time. The government isn’t helping by turning away foreign students, damaging one of the UK’s most promising export sectors.

The government claims that the alternative to today’s VAT rise is bigger spending cuts. But that isn’t true. Yes, the coalition government needed to set out a credible framework for stabilising the national debt, but its decision to tighten the screws so far and so fast was a political choice. It wouldn’t surprise me if Osborne was planning pre-election tax cuts for 2014.

Instead of raising VAT and national insurance this year, the government could introduce taxes on carbon and financial transactions next year. And it should levy a tax on land values. Since all the land in Britain is worth some £5 trillion, an annual levy of 1% could raise £50bn a year – without depressing economic activity, because land is in fixed supply: central London can’t be spirited away to a tax haven.

As well as preventing property bubbles (and busts), a land tax would be fair. A mere 160,000 people (mostly hereditary landowners) own more than two-thirds of Britain – and the value of that land increases not through their own striving, but through that of others. Surely it would be better to tax this windfall gain than the hard work and enterprise of those who generate it? And since infrastructure improvements, such as a high-speed rail network, boost surrounding land values, a land tax could also help to finance investment in future growth. There is an alternative to austerity – if only the government would listen.

Posted 05 Jan 2011 in Blog, Published articles

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